The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Hubei Feilihua Quartz Glass Co., Ltd. (SZSE:300395) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

What Is Hubei Feilihua Quartz Glass's Net Debt?

As you can see below, at the end of March 2024, Hubei Feilihua Quartz Glass had CN¥412.7m of debt, up from CN¥96.3m a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥970.9m in cash, so it actually has CN¥558.2m net cash.

How Strong Is Hubei Feilihua Quartz Glass' Balance Sheet?

We can see from the most recent balance sheet that Hubei Feilihua Quartz Glass had liabilities of CN¥1.10b falling due within a year, and liabilities of CN¥396.1m due beyond that. Offsetting these obligations, it had cash of CN¥970.9m as well as receivables valued at CN¥1.08b due within 12 months. So it actually has CN¥553.2m more liquid assets than total liabilities.

This surplus suggests that Hubei Feilihua Quartz Glass has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Hubei Feilihua Quartz Glass boasts net cash, so it's fair to say it does not have a heavy debt load!

But the other side of the story is that Hubei Feilihua Quartz Glass saw its EBIT decline by 9.1% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Hubei Feilihua Quartz Glass can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Hubei Feilihua Quartz Glass may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Hubei Feilihua Quartz Glass burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Hubei Feilihua Quartz Glass has net cash of CN¥558.2m, as well as more liquid assets than liabilities. So we don't have any problem with Hubei Feilihua Quartz Glass's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Hubei Feilihua Quartz Glass has 1 warning sign we think you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.